TAXATION
INTRODUCTION
This course is the second part of public sector economics taught to students at the
undergraduate level. The course is designed to give an insight into the theory of taxation,
impact of taxation on the economy, ways of appraising taxes and consideration of alternative
types of tax policies.
It is expected that students’ knowledge of tax issues will be broadened and a contextual
framework for studies in tax related issues will be developed. The students are encouraged to
use the lecture experiences to think critically on the approaches to taxation and existing tax
systems in their countries.
COURSE OBJECTIVES
By the end of the course the learner should be able to:
- Describe the various sources of public revenues
- Explain the canons of taxation
- Explain the approaches to each of the canons in the design of tax policy
- Explain issues for tax reforms in developing countries
- Explain the approaches to optimal public finance in federal systems
- Explain the burden of public debt
Page 1 of 118
,NOTE
The teaching and learning strategy will comprise a range of lectures, group and individual
learning activities. Each student must attend all lectures and be actively involved in all
scheduled group activities.
Continuous assessment tests and any other forms of course assessments will be given
according to schedules set by the instructor. All students are expected to demonstrate high
integrity and ensure full participation during such exercises.
Course grades are determined by cumulative performance over all assignments, continuous
assessment tests and a final exam. The distribution of marks for grading is as follows:
CATs and Assignment 30%: End of semester examinations 70%.
REFERENCES
Artkinson, A.B and J.E, Stiglitz (1980): Lectures in Public Economics. New York, McGraw-
Hill
Barley, S.J. (2002). Public Sector Economics Theory and Practice. 2nd edition. New York
Palgrave
Hillman, A.L (2009). Public Finance and Public policy- Responsibilities and limitations of
Government. Cambridge. Cambridge University Press
Howard, M (2001). Public Sector Economics for Developing Countries. Kingston 7.
University of West Indies Press
Musgrave and Musgrave (1989): Public Finance in Theory and Practice. 5thed. New York,
McGraw-Hill
Rosen H (2005): Public finance. 7th ed. McGraw-Hill
Stiglitz, J.E (2000): Economics of the Public Sector. 3rded. New York, Norton
Page 2 of 118
,TABLE OF CONTENT
TOPIC 1: AN INTRODUCTION TO TAXATION
1.1 Topic Objectives--------------------------------------------------------------------------- 7
1.2 Public Revenue: Definition and Sources----------------------------------------------- 9
1.3 Reasons for taxation----------------------------------------------------------------------- 9
1.4 Canons of Taxation------------------------------------------------------------------------ 9
1.5 Summary------------------------------------------------------------------------------------ 11
1.6 Self-Test Questions------------------------------------------------------------------------ 12
1.7 Further Reading---------------------------------------------------------------------------- 12
TOPIC 2: CATEGORIES OF TAXES
2.1 Topic Objectives---------------------------------------------------------------------------- 13
2.2 Tax impact points in the circular flow model and various types of taxes----------- 13
2.3 Other Categories of taxes------------------------------------------------------------------ 15
2.4 Summary------------------------------------------------------------------------------------ 16
2.5 Self-Test Questions------------------------------------------------------------------------ 17
2.6 Further Reading---------------------------------------------------------------------------- 17
TOPIC 3: APPROACHES TO TAX EQUITY
3.1 Topic Objectives-------------------------------------------------------------------------- 18
3.2 The Benefit Principle--------------------------------------------------------------------- 18
3.3 Ability to Pay Principle------------------------------------------------------------------- 21
3.4 Tax Progressiveness----------------------------------------------------------------------- 25
3.5 Summary------------------------------------------------------------------------------------ 28
3.6 Self-Test Questions------------------------------------------------------------------------ 29
3.7 Further Reading----------------------------------------------------------------------------- 29
TOPIC 4: TAXABLE CAPACITY AND TAX EFFORT
4.1 Topic Objectives--------------------------------------------------------------------------- 30
4.2 Taxable Capacity--------------------------------------------------------------------------- 30
4.3 Tax Effort----------------------------------------------------------------------------------- 34
4.4 Summary------------------------------------------------------------------------------------ 36
4.5 Self-Test Questions------------------------------------------------------------------------ 37
4.6 Further Reading----------------------------------------------------------------------------- 37
TOPIC 5: TAX BURDEN
6.1 Topic Objectives--------------------------------------------------------------------------- 38
6.2 Tax Liability, Tax Burden and Excess Burden of Tax-------------------------------- 38
6.3 Measuring Excess Burden of Tax------------------------------------------------------- 39
6.4 Summary------------------------------------------------------------------------------------ 42
6.5 Self-Test Questions------------------------------------------------------------------------ 42
6.6 Further Reading----------------------------------------------------------------------------- 42
TOPIC 6: TAX INCIDENCE AND TAX SHIFTING
5.1 Topic Objectives--------------------------------------------------------------------------- 43
5.2 Definitions---------------------------------------------------------------------------------- 43
5.3 Tax incidence Analysis-------------------------------------------------------------------- 45
5.4 Factors influencing the extent of Tax shifting------------------------------------------ 47
Page 3 of 118
, 5.5 Summary----------------------------------------------------------------------------------- 53
5.6 Self-Test Questions----------------------------------------------------------------------- 53
5.7 Further Reading--------------------------------------------------------------------------- 54
TOPIC 7: EFFECTS OF TAXATION ON ECONOMIC BEHAVIOUR
7.1 Topic Objectives--------------------------------------------------------------------------- 55
7.2 Introduction--------------------------------------------------------------------------------- 55
7.3 Effect of Income Tax on Labour Supply------------------------------------------------ 55
7.4 Effect of Income Tax on Savings-------------------------------------------------------- 59
7.5 Tax rates and Tax Revenues------------------------------------------------------------- 65
7.6 Summary------------------------------------------------------------------------------------ 67
7.7 Self-Test Questions------------------------------------------------------------------------ 68
7.8 Further Reading----------------------------------------------------------------------------- 68
TOPIC 8: OPTIMAL TAXATION
8.1 Topic Objectives--------------------------------------------------------------------------- 69
8.2 Optimal Tax-------------------------------------------------------------------------------- 69
8.3 Optimal Income Taxation----------------------------------------------------------------- 71
8.4 Optimal Commodity Taxation------------------------------------------------------------ 73
8.5 Summary------------------------------------------------------------------------------------ 76
8.6 Self-Test Questions------------------------------------------------------------------------ 77
8.7 Further Reading---------------------------------------------------------------------------- 77
TOPIC 9: TAX EVASION AND TAX AVOIDANCE
9.1 Topic Objectives--------------------------------------------------------------------------- 78
9.2 Definitions---------------------------------------------------------------------------------- 78
9.3 Consequences of Tax Evasion----------------------------------------------------------- 79
9.4 Causes of Tax Evasion and Avoidance------------------------------------------------- 79
9.5 Summary------------------------------------------------------------------------------------ 83
9.6 Self-Test Questions----------------------------------------------------------------------- 84
9.7 Further Reading---------------------------------------------------------------------------- 84
TOPIC10: TAX REFORM
10.1 Topic Objectives---------------------------------------------------------------------- 85
10.2 Motivations for Tax Reform--------------------------------------------------------- 85
10.3 Evaluation of Tax reform proposals------------------------------------------------ 85
10.4 Issues Motivating Tax reform Debates--------------------------------------------- 86
10.5 Economic problems in Developing Countries and Tax reforms---------------- 88
10.6 Case examples f Problems in Tax reforms Problems---------------------------- 90
10.7 Summary------------------------------------------------------------------------------- 93
10.8 Self-Test Questions------------------------------------------------------------------- 94
10.9 Further Reading----------------------------------------------------------------------- 94
TOPIC 11: FISCAL FEDERALISM
11.1 Topic Objectives---------------------------------------------------------------------- 95
11.2 Definitions------------------------------------------------------------------------------ 95
11.3 Optimal Federalism------------------------------------------------------------------- 96
11.4 Tax Assignment----------------------------------------------------------------------- 100
11.5 Tax Competition----------------------------------------------------------------------- 101
Page 4 of 118
INTRODUCTION
This course is the second part of public sector economics taught to students at the
undergraduate level. The course is designed to give an insight into the theory of taxation,
impact of taxation on the economy, ways of appraising taxes and consideration of alternative
types of tax policies.
It is expected that students’ knowledge of tax issues will be broadened and a contextual
framework for studies in tax related issues will be developed. The students are encouraged to
use the lecture experiences to think critically on the approaches to taxation and existing tax
systems in their countries.
COURSE OBJECTIVES
By the end of the course the learner should be able to:
- Describe the various sources of public revenues
- Explain the canons of taxation
- Explain the approaches to each of the canons in the design of tax policy
- Explain issues for tax reforms in developing countries
- Explain the approaches to optimal public finance in federal systems
- Explain the burden of public debt
Page 1 of 118
,NOTE
The teaching and learning strategy will comprise a range of lectures, group and individual
learning activities. Each student must attend all lectures and be actively involved in all
scheduled group activities.
Continuous assessment tests and any other forms of course assessments will be given
according to schedules set by the instructor. All students are expected to demonstrate high
integrity and ensure full participation during such exercises.
Course grades are determined by cumulative performance over all assignments, continuous
assessment tests and a final exam. The distribution of marks for grading is as follows:
CATs and Assignment 30%: End of semester examinations 70%.
REFERENCES
Artkinson, A.B and J.E, Stiglitz (1980): Lectures in Public Economics. New York, McGraw-
Hill
Barley, S.J. (2002). Public Sector Economics Theory and Practice. 2nd edition. New York
Palgrave
Hillman, A.L (2009). Public Finance and Public policy- Responsibilities and limitations of
Government. Cambridge. Cambridge University Press
Howard, M (2001). Public Sector Economics for Developing Countries. Kingston 7.
University of West Indies Press
Musgrave and Musgrave (1989): Public Finance in Theory and Practice. 5thed. New York,
McGraw-Hill
Rosen H (2005): Public finance. 7th ed. McGraw-Hill
Stiglitz, J.E (2000): Economics of the Public Sector. 3rded. New York, Norton
Page 2 of 118
,TABLE OF CONTENT
TOPIC 1: AN INTRODUCTION TO TAXATION
1.1 Topic Objectives--------------------------------------------------------------------------- 7
1.2 Public Revenue: Definition and Sources----------------------------------------------- 9
1.3 Reasons for taxation----------------------------------------------------------------------- 9
1.4 Canons of Taxation------------------------------------------------------------------------ 9
1.5 Summary------------------------------------------------------------------------------------ 11
1.6 Self-Test Questions------------------------------------------------------------------------ 12
1.7 Further Reading---------------------------------------------------------------------------- 12
TOPIC 2: CATEGORIES OF TAXES
2.1 Topic Objectives---------------------------------------------------------------------------- 13
2.2 Tax impact points in the circular flow model and various types of taxes----------- 13
2.3 Other Categories of taxes------------------------------------------------------------------ 15
2.4 Summary------------------------------------------------------------------------------------ 16
2.5 Self-Test Questions------------------------------------------------------------------------ 17
2.6 Further Reading---------------------------------------------------------------------------- 17
TOPIC 3: APPROACHES TO TAX EQUITY
3.1 Topic Objectives-------------------------------------------------------------------------- 18
3.2 The Benefit Principle--------------------------------------------------------------------- 18
3.3 Ability to Pay Principle------------------------------------------------------------------- 21
3.4 Tax Progressiveness----------------------------------------------------------------------- 25
3.5 Summary------------------------------------------------------------------------------------ 28
3.6 Self-Test Questions------------------------------------------------------------------------ 29
3.7 Further Reading----------------------------------------------------------------------------- 29
TOPIC 4: TAXABLE CAPACITY AND TAX EFFORT
4.1 Topic Objectives--------------------------------------------------------------------------- 30
4.2 Taxable Capacity--------------------------------------------------------------------------- 30
4.3 Tax Effort----------------------------------------------------------------------------------- 34
4.4 Summary------------------------------------------------------------------------------------ 36
4.5 Self-Test Questions------------------------------------------------------------------------ 37
4.6 Further Reading----------------------------------------------------------------------------- 37
TOPIC 5: TAX BURDEN
6.1 Topic Objectives--------------------------------------------------------------------------- 38
6.2 Tax Liability, Tax Burden and Excess Burden of Tax-------------------------------- 38
6.3 Measuring Excess Burden of Tax------------------------------------------------------- 39
6.4 Summary------------------------------------------------------------------------------------ 42
6.5 Self-Test Questions------------------------------------------------------------------------ 42
6.6 Further Reading----------------------------------------------------------------------------- 42
TOPIC 6: TAX INCIDENCE AND TAX SHIFTING
5.1 Topic Objectives--------------------------------------------------------------------------- 43
5.2 Definitions---------------------------------------------------------------------------------- 43
5.3 Tax incidence Analysis-------------------------------------------------------------------- 45
5.4 Factors influencing the extent of Tax shifting------------------------------------------ 47
Page 3 of 118
, 5.5 Summary----------------------------------------------------------------------------------- 53
5.6 Self-Test Questions----------------------------------------------------------------------- 53
5.7 Further Reading--------------------------------------------------------------------------- 54
TOPIC 7: EFFECTS OF TAXATION ON ECONOMIC BEHAVIOUR
7.1 Topic Objectives--------------------------------------------------------------------------- 55
7.2 Introduction--------------------------------------------------------------------------------- 55
7.3 Effect of Income Tax on Labour Supply------------------------------------------------ 55
7.4 Effect of Income Tax on Savings-------------------------------------------------------- 59
7.5 Tax rates and Tax Revenues------------------------------------------------------------- 65
7.6 Summary------------------------------------------------------------------------------------ 67
7.7 Self-Test Questions------------------------------------------------------------------------ 68
7.8 Further Reading----------------------------------------------------------------------------- 68
TOPIC 8: OPTIMAL TAXATION
8.1 Topic Objectives--------------------------------------------------------------------------- 69
8.2 Optimal Tax-------------------------------------------------------------------------------- 69
8.3 Optimal Income Taxation----------------------------------------------------------------- 71
8.4 Optimal Commodity Taxation------------------------------------------------------------ 73
8.5 Summary------------------------------------------------------------------------------------ 76
8.6 Self-Test Questions------------------------------------------------------------------------ 77
8.7 Further Reading---------------------------------------------------------------------------- 77
TOPIC 9: TAX EVASION AND TAX AVOIDANCE
9.1 Topic Objectives--------------------------------------------------------------------------- 78
9.2 Definitions---------------------------------------------------------------------------------- 78
9.3 Consequences of Tax Evasion----------------------------------------------------------- 79
9.4 Causes of Tax Evasion and Avoidance------------------------------------------------- 79
9.5 Summary------------------------------------------------------------------------------------ 83
9.6 Self-Test Questions----------------------------------------------------------------------- 84
9.7 Further Reading---------------------------------------------------------------------------- 84
TOPIC10: TAX REFORM
10.1 Topic Objectives---------------------------------------------------------------------- 85
10.2 Motivations for Tax Reform--------------------------------------------------------- 85
10.3 Evaluation of Tax reform proposals------------------------------------------------ 85
10.4 Issues Motivating Tax reform Debates--------------------------------------------- 86
10.5 Economic problems in Developing Countries and Tax reforms---------------- 88
10.6 Case examples f Problems in Tax reforms Problems---------------------------- 90
10.7 Summary------------------------------------------------------------------------------- 93
10.8 Self-Test Questions------------------------------------------------------------------- 94
10.9 Further Reading----------------------------------------------------------------------- 94
TOPIC 11: FISCAL FEDERALISM
11.1 Topic Objectives---------------------------------------------------------------------- 95
11.2 Definitions------------------------------------------------------------------------------ 95
11.3 Optimal Federalism------------------------------------------------------------------- 96
11.4 Tax Assignment----------------------------------------------------------------------- 100
11.5 Tax Competition----------------------------------------------------------------------- 101
Page 4 of 118
